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Executives

Kenneth J. LeStrange - Chairman, President and CEO

Michael J. McGuire - CFO

Michael Angelina - Chief Actuary and Chief Risk Officer

David S. Cash - Chief Underwriting Officer

Analysts

Susan Spivak - Wachovia Securities

Matt Heimermann - JP Morgan

Jay Cohen - Merrill Lynch

Endurance Specialty Holdings Ltd. (ENH) Q4 FY07 Earnings Call February 7, 2008 8:30 AM ET

Operator

Good morning, everyone, and welcome to the Endurance Specialty Holdings Fourth Quarter and Full Year 2007 Earnings Results Conference Call. This call is being recorded. Your lines will be in listen-only mode during the presentation. You will have an opportunity to ask questions after the presentation. Instructions will be given at that time.

I would like to now turn the call over to Greg Schroeder [ph], Vice President of Investor Relations and Corporate Development. Please go ahead.

Unidentified Company Representative

Thank you, Dennis, and welcome to our call. Hosting today's call will be Ken LeStrange, Chairman, President and Chief Executive Officer; Mike McGuire, Chief Financial Officer; David Cash, Chief Underwriting Officer; and Mike Angelina, Chief Actuary and Chief Risk Officer.

Before I turn the call over to Ken, I'd like to note that certain of the matters that will be discussed here today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties and a number of factors that could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements are sensitive to many factors including those identified in Endurance's Annual Report on Form 10-K and other documents on file with the SEC that could cause the actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as of the date on which they are made and Endurance undertakes no obligation publicly to update or revise any forward-looking statements whether as a result of new information, future developments, or otherwise.

I'd now like to turn the call over to Ken LeStrange.

Kenneth J. LeStrange - Chairman, President and Chief Executive Officer

Thank you, Greg. Good morning, and welcome to everyone participating in our fourth quarter and full year's earnings call. 2007 was an excellent year for Endurance from both a financial and strategic perspective.

During the fourth quarter, we generated net income of $153 million, representing $2.18 per diluted common share. For the full year, we reported record net income of $521 million or $7.17 per diluted common share. Annualized operating return on equity was 27.1% for the fourth quarter and 23.8% for the full year. Our total gross written premiums were $278 million in the fourth quarter. As in recent quarters, we have seen a decline in revenue in our Reinsurance segment as we continued to adhere to our underwriting and pricing standards. At the same time, we have found profitable specialty opportunities in our Insurance segment. For example, our new agriculture Insurance unit, ARMtech, wrote $42 million of premiums in the fourth quarter.

In 2008, it appears the market conditions will continue to soften, barring any dislocating events. In this environment, it is critical to maintain a keen focus on each specialty unit's level of price adequacy and to be selective and disciplined in our underwriting. Since our inception as a company, Endurance has demonstrated a strong ability to navigate the cyclical nature of our industry. We remain committed to taking... only taking risk when it is rewarded by an appropriate return. You will continue to see our business units and segments grow and shrink, consistent with our view of the adequacy of pricing levels.

In 2007, we were successful in implementing a number of strategic initiatives to further enhance our competitive position. We acquired ARMtech, which provides us with a very significant and attractive portfolio of agriculture Insurance business. With this acquisition, we should achieve a good balance between our Insurance and Reinsurance premium writings in 2008. This acquisition has also improved the diversification of Endurance's overall risk profile.

We recruited key talent to expand our array of specialty businesses. Specifically, we hired several key individuals to establish new Reinsurance offices in Switzerland and Singapore. We also added seven new teams of people to our U.S. Insurance operations, each focused upon a specialty niche with attractive prospects for growth and profit. At the same time, we've also optimized our capital base through the repurchase of over $300 million of our shares, representing 12% of our beginning-of-the-year common shares outstanding. We also paid $64 million in dividends on our common shares during the course of 2007. With these actions, we've laid the foundation for us to continue to achieve our strategic objectives.

I would now like to turn the call over to Mike McGuire to review our financial results in more detail.

Michael J. McGuire - Chief Financial Officer

Thank you, Ken, and good morning everyone. For the fourth quarter, Endurance earned net income of $153 million and $2.18 per diluted common share. Endurance achieved record results for the full year with $521 million in net income and $7.17 per diluted common share. Operating income for the fourth quarter of 2007 was $161 million and $2.30 per diluted common share, and $541 million and $7.45 per diluted common share for the full year. Our combined ratio was 74.7% in the fourth quarter and 79.9% for the full year of 2007. The favorable combined ratios were driven by strong underwriting results in our Reinsurance segment, reflecting a relatively low level of U.S. catastrophe losses experienced in 2007.

Our fourth quarter results included $38 million or 9.6 points of favorable prior-year reserve development, split 60% from short-tailed lines and 40% for long-tailed lines. The current quarter's combined ratio was also favorably impacted by approximately $72 million or 18 percentage points of favorable current year reserve development due to lower than expected short-tailed claim emergence from the first nine months of 2007.

Our full-year results included $159 million or 10 points of favorable prior-year reserve development, with about two-thirds coming from short-tailed lines and one-third for long-tailed lines. In our Insurance segment, we had a few items of noise that pushed the quarter's combined ratio above a 100%. A large individual risk property loss added about 8 points to the Insurance segment's loss ratio. In addition, in both segments we continued to invest in the people, technology, and infrastructure required to support the many new teams and offices we have recently brought online that are just now beginning to write business. These startup costs added about 2 points to our overall G&A ratio and 4 points to the Insurance segment G&A ratio for the quarter. Finally, year-end incentive compensation adjustments added about 2 points to our overall G&A ratio and 3 points to the Insurance segment G&A ratio. We remain confident in the underlying strength and margins of our developing insurance business as evidenced by the Insurance segment's calendar year combined ratio of 90.1% and an inception-to-date Insurance combined ratio of 90.6%.

Moving on to premiums, in the fourth quarter our gross written premiums declined about 4.5% to $278 million. Declines in our Reinsurance segment were partially offset by growth in our Insurance segment, mainly in our agriculture and workers’ compensation insurance lines. Declines in Reinsurance during the fourth quarter came from the non-renewal of several causality reinsurance accounts that fail to meet to our return requirements. In addition, the fourth quarter of 2006 included about $35 million of premiums from adjustments and policy extensions compared to only $13 million of such adjustments in the fourth quarter of 2007.

For the full year, our total premiums were $1.8 billion, down about 7% with declines in reinsurance as we non-renewed accounts throughout the year that did not made our return requirements. Full-year Insurance premiums were up driven by workers’ compensation and agriculture. On some of our more mature Insurance lines of business, we did see some rate reductions and participation changes as we moved up into higher Insurance layers with lower associated premiums.

For our new agriculture insurance unit, although we do not provide topline guidance, I will try to provide you with a sense of the seasonality you should expect to see in this line of business. Written premiums related to a crop year are generally recorded beginning in the fourth quarter for the following year's growing season. As a point of reference, ARMtech recorded approximately $64 million of 2008 crop year premiums in the fourth quarter of 2007, $42 million of which was written subsequent to our acquisition. Premiums written in the first quarter of 2008 are expected to be relatively modest with a small uptick in the second quarter followed by the highest proposition of annual premiums expected to be recorded in the third quarter. Although the premiums will be earned throughout the year, we do expect premium earnings to be concentrated in the second half of the year.

Net investment income was $65 million in the quarter, down 9% from the same period in 2006, primarily due to a $7.8 million decline in the performance of the company's alternative investments. In the alternative portfolio, we target returns of 500 basis points over risk-free rates and we nearly achieved that during 2007, earning 8.7% for the year. As we've said before, we expect our returns in this asset class to be lumpy and 2007 certainly was. The first half of the year saw strong increases in values, while the second half of the year saw values remain largely unchanged as the recent market volatility limited the alternative fund's performance.

Our investment strategy has always been focused on preserving our capital and liquidity and generating an appropriate risk-adjusted return on invested assets. In the recent market environment, where the compensation for credit risk has remained insufficient for increasing volatility and default risk, we have maintained our very high quality portfolio with an average rating of AAA. To date, our goal… our portfolio has not experienced any significant downgrades.

On the margins, we've reduced our limited exposure to financial means and confined new purchases to high quality sectors at the top of the capital structure. We’ve provide additional information on the quality of our investment portfolio on pages 24 and 25 of our investor supplement, which is available on our website.

We ended the fourth quarter with total shareholders' equity of $2.5 billion. Our annualized operating return equity was 27.1% for the fourth quarter and 23.8% for the full-year 2007. Our diluted book value per share at ended the year at $35.05, up 21% from a year ago. Year-to-date, growth in book value per share plus dividends paid was $7.18 per share, representing an annual return of 25% on beginning book value per share.

On the capital management front, we had a strong finish to the year. We repurchased $200 million or approximately 5 million shares during the fourth quarter in both public and private transactions. For the full year, we repurchased over 8 million shares for $312 million, which is approximately 12% of our beginning share count. We also paid $64 million in dividends to our common shareholders during the year.

In addition to our share repurchases and dividends, earlier in the year, we renewed and expanded our five-year credit facility at improved terms. We established a $150 million variable equity facility to enhance our financial flexibility and provide an efficient source of off-balance sheet capital, and in December, we completed the acquisition of ARMtech. Finally, we received an upgrade to A from AM Best in recognition of our strong risk management, exceptional financial returns, and our disciplined capital management.

Disciplined and active capital management has been a hallmark of Endurance since inception. We are committed to maintaining strong levels of capital to support both our internal and external capital requirements. However, returning excess capital to our shareholders, if it cannot be reasonably deployed, is a key principle of our capital management and one to which we remain firmly committed.

I'll now turn the call over to Mike Angelina.

Michael Angelina - Chief Actuary and Chief Risk Officer

Thank you, Mike, and good morning everyone. Our reserves across all prior period, which includes the first nine months of the 2007 accident year, developed favorably in total by $110 million in the fourth quarter of 2007, with the majority arising from the property lines of business and our Reinsurance segment. Approximately $72 million of this favorable development is attributable to accident year 2007 with virtually all of the favorable emergence arising from our short-tailed Reinsurance lines, as the actual loss emergence was less than expected with the premiums earned in the first nine months of the year. The remaining $38 million of favorable development in this quarter arises from accident years 2006 and prior. This development is comprised of $10 million from the Insurance segment and $28 million from the Reinsurance segment. For the Insurance segment, the favorable development was largely generated by our casualty lines of business. The majority of this business is written on claims made over the Bermuda accounts reported type forms. For the Reinsurance segment, over 75% of the $28 million of favorable development came from our short-tailed lines of business.

With regards to our casualty line, in both our Insurance and Reinsurance segments, IBNR reserves represent approximately 83% of our total long-tailed reserves of $1.8 billion. The treaty casualty IBNR in our Reinsurance segment is $580 million or 70% of the total reserves for this class. The book loss ratio in our Reinsurance segment is about 63% across all accident years versus the initially priced loss ratio of 64%. In the treaty casualty reserves in our Reinsurance segment, 24% of our case outstanding losses are additional case reserves or more commonly referred to as ACRs. These ACRs, which are in addition to IBNR, are the result of the ongoing claims audit performed by our claims team.

Our loss ratio for the current accident year was 45% for the fourth quarter of 2007 and 57% for the full year. The full accident year loss ratio is 50% for our Reinsurance business, reflecting the lower level of catastrophe activities, as two-thirds of this segment is short-tailed in nature. This estimate also includes approximately $60 million or 6 loss ratio points related to Windstorm Kyrill, California wildfires, and flooding in Europe and Australia.

The full accident year loss ratio for our Insurance segment is 74%, which may initially appear higher than anticipated, but it is driven by the following factors. Casualty business accounts for 90% of the Insurance segment’s 2007 accident year premium base, which is reserved at a 71% loss ratio. While this is 8 points higher than our inception-to-date results, it is consistent with our historical reserving philosophy for less mature accident years. As we've discussed in the past, a significant portion, namely 60 loss ratio points, of our 2007 accident year loss ratio, is comprised of IBNR reserves, which totaled $300 million.

Secondly, third party reinsurance purchases, which included proportional excessive loss and a portion of the Shackleton transaction, contributed 11 points to the Insurance segment’s net loss ratio, since there was no activity to trigger the non-proportional covers. As we've built out our U.S. Insurance platform, we've used third-party reinsurance capital to protect both our U.S. Insurance business and our corporate balance sheet against significant peak risk on both the property and the casualty exposures.

As part of our ongoing enterprise risk and capital management strategy, we continue to evaluate the risk versus the reward trade-offs for the 12-month capital relative to our corporate risk appetites and market conditions. To date, we've allowed some of these programs to expire and the effects are already included in current [inaudible] risk curve. In addition, the 2007 accident year loss ratio for both segments included the IBNR associated with our exposure to subprime losses. At this point in time, based upon the information currently available to us, we feel that our subprime losses are contained within our current IBNR levels. We will continue to monitor this casualty event closely for further developments and make any adjustments warranted by the additional information received.

Outside of these events, we continue to see favorable loss activity in our catastrophe exposed lines of business, namely property and catastrophe reinsurance and our U.S. property insurance business. We are currently holding approximately $187 million of IBNR for our short-tailed lines of business for the 2007 accident year in addition to the $118 million of case reserves. Over 30% of these case reserves include our provision for Windstorm Kyrill and other events. In addition, we are holding $78 million of IBNR for the 2006 accident year for our short-tailed lines of business relative to $302 million of case incurred losses.

With regard to the pricing environment for the full year of 2007, our overall rate monitoring highlights a decrease in pricing across all of our business lines, with slightly larger decreases in the casualty lines. Along with decreases in pricing, we have seen unfavorable changes in terms and conditions. We believe we have experienced milder increases [ph] than industry trends would suggest due to intentional changes we haven’t implemented in our mix of business. As always, we will continue to monitor rate levels, pricing trends, and the external environment as we seek to most efficiently deploy our capital and our resources.

Lastly, I would like to direct your attention to the... to our additional financial supplement containing our loss development triangles. We have been committed to being on the forefront of our industry in many areas, including capital management, financial disclosure, and enterprise risk management. Releasing our loss development triangles reaffirms this commitment. The triangles and the supporting exhibits are presented on an accident year basis and expand our segment level information to highlight differences that exist in broad reserving classes, such as motor liability versus workers’ compensation for some of the long-tailed lines.

The summary exhibits mirror the information found in Schedule P of the NAIC Annual Statements for U.S. domiciled companies in that they are represented on an accident year basis, highlighting growth, ceded and net results, incorporating management's best estimate of reserves. The reserves are separated into case outstanding, additional case reserves, and IBNR by accident year and triangle class as of December 31, 2007. We also strongly urge you to read the included narrative to fully understand the data presented in the supplement.

I would now like to turn the call over to David Cash.

David S. Cash - Chief Underwriting Officer

Thank you, Mike, and good morning everyone. For my portion of the call, I will provide comments on the Insurance and Reinsurance markets at January 1, 2008.

The underwriting environment at January 1 was quite competitive. While this competition was most evident in the Reinsurance market, it extends into the Insurance market as well. In each of our underwriting markets, Bermuda, Europe, London, and the U.S., there was a full slate of competitors present at 01/01. There were some signs of caution on the parts of competitors, but in the main, the underwriting posture we observed was slightly aggressive. This combined with the willingness in the part of clients to accept coverage from newer markets made for an overall reduction in pricing in many of our businesses.

Before moving on to specific market commentary, I should close this section by noting that even as the market weakens, Endurance's underwriting performance to date has been very strong. If one takes the time to review the loss development triangles we’ve published this quarter, one would see very high inception-to-date reported underwriting margins on the business we underwrite. The combination of strong historic underwriting margins, prudent approach to reserving, and a proactive approach to cycle management gives me considerable comfort that we are reading the market cycle honestly and further that the lines of business we’ve built our company around are more than capable of producing acceptable returns even if the market may be in a challenging phase.

In the Reinsurance segment, our premiums in Q4 were down over 2006, in places materially. Because of the relatively small size of the fourth quarter versus other quarters it was not surprising for me to see these reductions. The reductions were more a reflection of the relative lumpiness of the fourth quarter hook than an indicator of market conditions.

In the case of our casualty line of business, the bulk of this reduction came from exiting Q3 days where one competitor made some surprising changes to pricing terms and conditions. We did not see any examples of treaties changing in attractiveness to such an extent either in the fourth quarter or in Q1 of this year.

Looking forward, we observed the following trends at 01/01. In our catastrophe line of business, our book largely held its own. In some markets, we saw reductions in our writings, this is true in Europe, but in the main we expect this portion of the segment to continue its recent strong performance in 2008. Starting in 2006 and continuing in 2007, we made a conscious effort to cut back on general property and casualty programs that we considered poorly priced. As a result of these early reductions, our book of business this 01/01 will not be much changed from last year. While there were places where we saw pricing we could not support, we were largely able to renew our portfolio. I would just note that it's in this area that we find ourselves setting up the largest portion of our ACRs, a sign that others may be misjudging risks in these lines of business.

In our specialty lines, with one exception, agriculture, our business held its own this January. In a few places such as marine, we saw some growth, while in others such as aviation some shrinkage.

Finally, in the agricultural reinsurance line, we faced a very dynamic marketplace this 01/01. In a couple of places, large cedents reduced their session significant. This combined with some newer participates... participants in the Reinsurance sector resulted in instances were pricing weakened noticeably. As a result of the preceding, we expect our share in this market to reduce significantly this year. This will of course be more than offset in terms of premiums for the ramp-up of ARMtech in 2008.

In the Insurance segment, as we have talked about the increasingly competitive conditions in the Reinsurance marketplace, it's important to emphasize that while we are seeing price reductions in the Insurance market the segment remains generally attracted to underwriting. Margins, while compressed, remain quiet positive. The challenge that we and our competitors face is one of managing our system distribution in a way that ensures we are underwriting familiar business that is not acceptably marketed. This is a place we've worked hard to get to. The work we've done over the last few years to build out infrastructure and balance sheet and to bring onboard seasoned underwriting teams should differentiate us from others who are only now starting this process. As of today, our underwriting plans call for a combination of defensive renewal focused underwriting on our existing book of business along with a targeted growth of new businesses where our relationships will allow us to move stable books of business to our balance sheet. The transaction we closed with ARMtech last quarter is an example to such growth.

While it's clear we are in a tough portion of the underwriting cycle, we do not believe our book of business... we do believe our book of business is well positioned to weather the current condition. In Bermuda, we have seen some shrinkage in the book of business over the last four quarters. At the same time, our renewal ratios are strong. They were north of 75% in 2007, and even as we have held on to our renewals we have continued to see and bind new business.

Finally, it's our sense that some of the competitive pressure from [inaudible] underwriters has leveled off, something that will likely become more evident during 2008. In the U.S, our Insurance operations face aggressive competition, although at the same time we continue to see opportunities to add new businesses. The branches we've opened up in Atlanta, St. Louis, Seattle, and Stamford will have a positive impact on our prospective production levels. At this point, the book of business is closing in on critical mass and we are expecting it to become an increasing contributor to the company results going forward.

Our California workers’ compensation business continues to perform well. In 2007, this business produced just north of $250 million in premium for the company. We'd expect to see some growth in this book of business in the early part of 2008, after which we anticipate beginning the process of shrinking this book in line with market conditions. By the second half of 2008 we would expect this book to be largely a renewal book of business reducing in size quarter-over-quarter, in line with rate reductions and normal levels of attrition.

Finally, before handing the call back to Ken, I would just extend Mike McGuire’s commentary on ARMtech, in particular the $42 million in gross insurance premiums written in the quarter. This represents protections purchased by farmers for winter crops such as winter weeds and some California crops. These numbers were roughly in line with our expectations for the book of business and suggest that the work that ARMtech has been doing with its agents since the September 7 announcement of the acquisition has been well received both by agents and clients.

With that, I'll turn the call over to Ken for his concluding remarks.

Kenneth J. LeStrange - Chairman, President and Chief Executive Officer

Thank you, David. As we begin 2008, I expect Endurance's agility and specialty focus to continue to differentiate our performance in an increasingly competitive market. We remain committed to specialized technical underwriting. We are aggressive in seeking opportunities to write attractive new business, and we are diligent in retaining our existing business consistent with our pricing and underwriting requirements. We remain committed to returning excess capital to our investors if it cannot be properly utilized to further expand our business.

Looking forward, Endurance remains committed to our long-term goal of generating 15% return on equity on average through the underwriting cycle. For the year 2008, we expect to generate an ROE of between 14.5% and 16.5% based upon our expected level of catastrophe events and our current view of market conditions.

Dennis, I would now like to open up the lines for our Q&A session.

Question and Answer

Operator

[Operator Instructions]. Your first question will come from the line of Susan Spivak with Wachovia.

Susan Spivak - Wachovia Securities

Good morning, Ken and Dave. I was hoping if you could just follow up a little bit and give us an outlook on what you see based on the January, what could happen in the June and July renewals, and how much of your book does renew then? And then second, Ken, if you could just update us on what you see going on in the M&A environment in terms of the flow of deals similar, say, to the ARMtech, etcetera?

David S. Cash - Chief Underwriting Officer

Hi, Susan, it's David. I will take the April and June question. April 1, it's not that large of a renewal base for us in the U.S. It is a little bit larger on the international side where we have the Japanese treaties that renew. I am not expecting any unusual movement there. The Japanese market has softened fairly steadily over the last few years, and my perception is that softening will not necessarily continue, it will probably flatten out, maybe down a little. And if that is the case I expect our international writings there to be somewhat what they were last year.

In the U.S., I don't have any sense that we are expecting changes that would make that market uncomfortable for us. Really, in 2006 and 2007, we made some pretty significant moves onshore in terms of how we position that book. What I saw generally with our U.S. book at January 1 was it held its own very comfortably and I’d expect something similar in that second quarter.

Looking forward to June 1 when the Florida business renews, in truth it's a little bit early to offer an opinion. In the next couple of months, we start to have the clients flow through Bermuda and talk about their programs and then we get kind of the first sort of look and feel for the sense of how our clients are positioning and we start to get a feel for how competitors are positioning. But I would be startled if pricing in Florida comes down to the extent it did last year. I expect a bit of erosion in pricing, but not much. Given the size of that book for us, I would see us holding around there in Florida as well.

Kenneth J. LeStrange - Chairman, President and Chief Executive Officer

Susan this is Kenneth. With regard to the M&A activity, I've been surprised over the past several years as to how active the flow of opportunities has been in M&A, all types of opportunities. And it's feeling to me early in '08 like the activity has picked up somewhat. We see a great number of opportunities in the course of the year, and given time we tend to be working on one or more of them. And as you can see, very few end up coming to fruition, but I think where we have been able to bring then to fruition they have been very powerful in terms of driving our results. So we are very active and focus both proactively in seeking opportunities that fit our goals and objectives and also in reacting to the things that are brought to us.

Susan Spivak - Wachovia Securities

Thank you, Ken. Thanks, Dave.

David S. Cash - Chief Underwriting Officer

You're welcome.

Operator

Your next question will come from the line of Matthew Heimermann with JP Morgan.

Matt Heimermann - JP Morgan

Hi. Good morning, everyone. A couple of questions, first was just generally on the expense. When you… Dave, you made the comment that you're getting close to critical mass. Does that mean we're couple of pretty much through the expense build at this point?

Michael J. McGuire - Chief Financial Officer

Hi, Matt. It’s Mike McGuire. I did mention in my remarks that for the quarter we did see some startup costs related to people, technology, infrastructure, both in Insurance and Reinsurance. That added about 2 points to our G&A ratio. We're starting to see those businesses come online right now, and really we'll obliviously remain disciplined in how we manage our expenses, given the market conditions. But we think we are somewhat turning the corner in terms of the investments that we're making and we hope to see those start to generate returns for us and then in the year 2008.

Matt Heimermann - JP Morgan

And then just following up on that, how much… as you start to pull back on some of these other businesses, is there much variable expense in those areas that actually you could get a little bit relief as you’re pulling back are those businesses pretty much fixed expense businesses?

Michael J. McGuire - Chief Financial Officer

Well, Matt, this is Michael McGuire. I’ll start and then maybe Ken or David could answer that as well. Within our workers’ compensation line of business, the vast majority of the expense load on that business is variable with the premium level. So as that business expands and contracts, we would expect to see the total expense ratio be pretty proportional to that movement.

David S. Cash - Chief Underwriting Officer

Maybe the only thing I would offer to Mike, in our Reinsurance line just the last couple of years where we have called back from some markets, I think that pullback is largely complete and… where we were sort of I would say for a period of time upside down on expenses and in individual business unit there. I can't see that really that sort of that imbalance. And so, I would say, maybe [inaudible] I think we're kind of turning the corner in the number thought there is.

Matt Heimermann - JP Morgan

Okay. The other question was, can you walk through just the financial institution or professional lines exposure you have, both in the Insurance and Reinsurance segments?

David S. Cash - Chief Underwriting Officer

Sure, Matt. At the moment, Endurance, we underwrite professional lines, Insurance, and Reinsurance. If you look at the sum total of that book of business, it's about $110 million of premium, maybe a $115 million premium. About $45 million of that comes from the Reinsurance side and the other $70 million just comes from the Insurance side. On the Reinsurance side, the bulk of that is what I would call commercial classes of insurance, not FI business, a portion of it is FI but not much. On the Insurance side, probably about half of the book of business is FI, the other half is what I'd call commercial classes that are employment practices liability. When we venture the process of establishing reserves for this year-end, we did essentially a top to bottom review of where we might have FI exposure, where we might have clients who’re exposed to this event. On the Reinsurance side, we spend actually with our key clients and they're very encouraging. In every instance we got a very thorough accounting of the risks they had. We're able to look into their books of business and see where they had concentrations that might relate to this business. And then probably, some losses that come from there, I'm not expecting them to be major. I'm very confident that our cedents have a real handle on that risk and are not at the epicenter of this event.

Matt Heimermann - JP Morgan

Okay. And then... Sorry, keep going.

David S. Cash - Chief Underwriting Officer

On the Insurance side, our FI book of business is in the man focused on insurance companies. So like some health writers, P&C writers, and also what I call asset managers, mutual fund managers, institutional managers. Those companies while they clearly kind of purchase assets, I mean arguably are sort of in the space where there could be some losses. They are definitely not at the center the kind of liquidity crisis we experienced in subprime crisis where we’ve really focused our efforts, our attention to being what I call kind of the larger banks, the kind of complex banks, money central banks, and investment banks. Within our book of business right now we have, I'd say, less than $5 million of premiums that comes from that space and some of the associated kind of servicers that sit around it. A portion of that is what I would call employment practices liability or bankers blanket bond, and about $2 million to $3 million of that would become E&O classes or potentially sort of E&O classes. We have a limited number of notices at this point, no sign of notices that are yet that are yet at a sufficiently developed stage that you could case reserve them, but clearly some of them requires some attention. And [inaudible] kind of a renewing of the book to identify where those existed and then a process of using legal resources, our claims resources, and underwriters try and establish reserves. And as Mike said, we have accounted for that in our reserves this year-end.

Matt Heimermann - JP Morgan

Okay, that's really… I am sorry to keep cutting off. I guess the follow-up question then is just in the insurance segment is that in Bermuda or U.S… out of Bermuda U.S. operations, and then on the Reinsurance side, I'm a bit curious by… if maybe regionally you can talk about who the cedents… where the cedents originate?

David S. Cash - Chief Underwriting Officer

It's hard to talk specifically about the cedents, but the professional and insurance book really does come largely from Bermuda. There's a portion we write out off San Diego that’s small, kind of miscellaneous E&O business that I think was about $10 million for last year in premium. On the Reinsurance side, we have a couple of kind of one large cedent in particular. They are not particularly tolerant in the news right now in terms of the kind of discussion around subprime. Their book of business is in part focused on smaller miscellaneous classes as you know. They do absolutely write the public companies. If you look within their portfolio, it's skewed more towards what we call non-financial classes, some of the commercial classes. They have some financial institutional exposure in their book.

Matt Heimermann - JP Morgan

Okay. That's extremely helpful. Thank you.

David S. Cash - Chief Underwriting Officer

You're welcome.

Operator

Your next question will come from the line of Jay Cohen with Merrill Lynch.

Jay Cohen - Merrill Lynch

Hey, three questions. I guess first, can you talk about your thoughts around ROE in that guidance? And I know that I shouldn’t use the word guidance. I know it's not guidance. But your ROE kind of goals, are you building in the expectation of continued favorable development or will that been seen as sort of extra?

Kenneth J. LeStrange - Chairman, President and Chief Executive Officer

We are not building any expectation of positive or negative development on our reserve base.

Jay Cohen - Merrill Lynch

Makes sense. Next question, I guess for Mike Angelina. You mentioned you had $187 million of IBNR related to short-tailed lines written in '07. A year ago, you gave us a similar statistic for the '06 year. My question is if you remember what the number was, but how do you see that develop? I won't be too much into the kind of comparison, but what was your experience last year at this time with the IBNR on the short-tailed lines for the '06 accident year?

Michael Angelina - Chief Actuary and Chief Risk Officer

No, that's completely fair, and the number at the end of '06 for the '06 accident year was about $250 million. And if you really just look at some diagnostics and compare that to the 187, I just want to give you a couple of caveats. One, it’s applied to a basic premium that is smaller than it was in the past. So if we looked at the 250, it was relative to about 1.1 billion of earned premiums and that was about an IBNR to earned premium, that 23%. In the end, for the year as Mike McGuire said earlier, we had favorable emergence for the year mostly from our short-tailed lines. That number came down by about $60 million or so. If you compare the 187 to our short-tailed lines of business in terms of premium it's about $900 million of premium or about 21%, so 23 went to 21. We had some favorable emergence. The other thing that needs to be factored in is the... when you look at the '06 earned premium, it was at a higher rate level base, these new markets with short-tailed lines, particularly cat in the U.S… U.S Cat was much stronger than it was in '07. I guess if you want to look at the… the last diagnostic I'll give you is basically ' 07 versus ‘06 loss ratio, '07 booked at about where '06 is now, about 35% loss ratio.

Jay Cohen - Merrill Lynch

Okay, great. I guess on this topic, in the quarter you had, I guess a reasonable amount of current year favorable development because of a lack of loss emergence. When you see that in the fourth quarter, does that make you reevaluate how you are booking the current quarter or as you go in to ' 08, does that play into it or it was just, good weather, we got lucky, let’s move on, how much of that play a role?

Michael Angelina - Chief Actuary and Chief Risk Officer

Clearly, wind season happens in the third quarter for U.S. exposures and you certainly have European wind season in the first quarter. What we do is when we get to the fourth quarter, you have a lot more balanced in the accident year results and you know a lot more of facts about events and because of that, because you're more premium that is being earned, we have a better sense as to what happened in the year, what type of activities are out there that we need to be worried about or concerned about that we need IBNR for. As we looked at '07, we knew we had Kyrill, we had California wildfires, we had Australia and U.K. floods, but at the end of the day we felt the IBNR true-up that we did at the end of '06 was consistent with what we would do in ‘07. Was that helpful?

Jay Cohen - Merrill Lynch

Yes, that's helpful. I guess the last question, maybe for Ken or David Cash, retentions… on the reinsurance side retentions among your ceding clients clearly have gone up. At some point you'd say these services can't take any more risk. Are we getting to that point? What do you expect to see those retentions continue to rise or should it begin to level off and maybe stabilize in '08?

Kenneth J. LeStrange - Chairman, President and Chief Executive Officer

Jay, Ken. I think we are at one of those inflection points. So it'll be interesting to see what actually happens. I think what we have seen in terms of ceding companies retaining more of their business over time is reflective of the challenges for growth that so many companies have, and that's an easy way to generate growth in a given year by retaining more of your business. It is a little bit counterintuitive because people tend to do that as the market is softening as well as reinsurance pricing softening. What we have seen in past cycles is that the market moves beyond that and then almost all of a sudden you start to see very large premium items coming into the Reinsurance market that are driven by companies looking to build a little bit more security around their results and perhaps to optimize their own results on a net basis, perhaps arbitrage in some cases. We have not seen that latter phenomenon yet, but I'm sensing, this is just intuition, that we’ll start to see it in '08 and there might be opportunities, if you will, to grow in the Reinsurance business. But I sense they won’t be high quality ones.

Jay Cohen - Merrill Lynch

Yes, that's when you have to be careful, I guess, as a reinsurance underwriter, you don't want to be at the other end of that arbitrage.

Kenneth J. LeStrange - Chairman, President and Chief Executive Officer

That's exactly right, and something I would like to highlight that was in David's portion of the script, the level of ACRs that we carry, a significant majority of those are obviously on casualty business, and we get to post those ACRs as a result of doing a very vigorous audit schedule in every given year. And that kind of information and those reserves would not be present in the underwriting submissions that companies are working off of and pricing off of. So when you think about the tipping points in our business when you go into unprofitability, we view the posting of those ACRs as a bit of a leading indicator, and we do factor those ACRs in our pricing. That is one of the things that sometimes will make us less competitive in the market around us. Obviously, it’s a correct view of pricing. You couple that with the pricing trends and exposure trends, and I think you get a picture particularly in the casualty treaty business in the U.S., it certainly gets soft, pretty soft.

Jay Cohen - Merrill Lynch

Great, that's helpful. Thank you.

Operator

[Operator Instructions].

Kenneth J. LeStrange - Chairman, President and Chief Executive Officer

Well, thank you very much for your time and attention today. We're very happy with the year we just posted, and we are very happy with the strategic positioning of Endurance for '08. We look forward to reporting our first quarter 2008 results to you. Thank you.

Operator

Ladies and gentlemen, this does conclude the Endurance Specialty Holdings fourth quarter and full-year 2007 earnings results conference call. You may now disconnect.

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Source: Endurance Specialty Holdings Ltd. Q4 2007 Earnings Call Transcript
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